Trump Tantrum

Donald Trump is campaigning for increased US production. What impact "Made in America" ??has on Asia, explains JOHCM Asia ex Japan fund manager Samir Mehta.

The sell-off in markets from May 2013 to August 2013 was labelled as a 'Taper Tantrum'. Last week’s dislocation in several asset markets across the world has a similar ferocity to that episode. Sharing the same initials (TT), we could call it the Trump Tantrum. This time the pace of adjustment is even more compressed, especially in emerging markets.

JOHCM fund manager Samir Mehta does not have any coherent answers on how events will pan out. But as several eminent historians and political commentators have opined, the election of Mr. Trump as POTUS and the vote for Brexit are reflective of deepseated angsts by large segments of the US and UK populations. These events had their seeds sown may years ago and came to a head with the global financial crisis of 2008.

Three things are immediately evident from these violent moves in markets:

1. After years of low growth in developed markets and intensifying deflationary conditions, the majority of portfolios are positioned for pockets of growth.

2. Attempts by central banks to stimulate growth and fight deflation drove bond yields to record low levels; a change in perception in the outlook for both those variables has sent yields much higher in recent days.

3. A combination of herd positioning, with a rise in yields pressurising carry trades and valuations, has resulted in panic selling across all emerging markets.

In Mehta's portfolio, by country, we can divide our holdings into two distinct groups – much on the lines of our process of (a) sustainable growth businesses and (b) cyclical stocks.

In the past 3-5 years, Taiwan, India and Indonesia were forced to make some structural changes, both at the macro level as well as individual company levels. After the taper tantrum of 2013, markets forced businesses to restructure their balance sheets, reduce costs and increase productivity, reflected in better margins and capital efficiency. That was the reason I held several stocks in these three countries.

Of these, India needs immediate attention. The move by the Indian government on 8th November 2016 to demonetise the Rs500 and Rs1000 notes will have major repercussions. In the long run, better tax compliance, more electronic banking and increased convenience will be good for the economy. In the short term, however, this move is deflationary. The total currency in circulation (CIC) is approximately US$250bn. Of this, 86% by value (US$215bn) is in the now demonetised notes. As a certain percentage of CIC is rendered worthless, there will be a contraction in money supply. Most of the current CIC will recirculate into bank accounts or into new notes, but some of it will look for alternate stores of value. Domestic gold prices are quoted 25-30% higher than international prices. Mehta hears of several schemes where middlemen will exchange old notes at 30-40% discounts.

A bazooka to kill a fly
Mr. Modi’s assault on corruption (after a failed voluntary disclosure income scheme) will have similar effects witnessed in China after Mr. Xi’s crackdown on corruption. In particular, high-end consumption/investment as well as luxury/semi-luxury goods and services (real estate, jewellery, hotels, luxury cars, etc.) will see abrupt slowdowns. In India, the last mile distribution is almost all in cash – retailers and distributors in general do not have point of sale terminals, and this could mean destocking in the near term, even in staples.

This policy has the right intentions but has the wrong approach; using a bazooka to kill a fly. It inconveniences 100% of the people and addresses maybe 10-15% of the problem. The stock of unaccounted wealth is not stored in cash; it is in real estate, gold or Swiss bank accounts.

It is likely the Reserve Bank of India will have to ease monetary conditions, even cut interest rates. This is necessary to counteract the deflationary effects but difficult in the current environment. Mehta has to relook at my holdings and reduce exposure. Within the portfolio he owns businesses in India that are robust and sustainable. Despite the slowdown in India, they have consistently delivered growth and performance. However, they are not cheap, which means de-ratings. More importantly, the growth trajectory that he expected in India will now be postponed or modified.

In core holdings in other countries, Mehta is assessing the impact of higher volatility of foreign exchange on margins as well as the effects on the potential demand for their products. He will have to trim back on some holdings in Taiwan that are exposed to exports into Europe and the US. This is precautionary based on perceptions of what might happen. So far, he remains convinced on the fundamentals of several of my core holdings but painfully aware of the de-ratings that this environment will bring.

On the cyclical front, especially China, Mehta does retain my view that the economy is stabilising after a brutal 2015 and perceptions and positioning are still negative. The cyclical stocks he owns are cheap, and he does not think we will lose too much money on them.

Protectionism redux?
What about the future? Our process is not based on predicting what might happen; Mehta is saying he is bad at that. JOHCM prefera to react to events, and this time is no different. The worst-case scenario is that we move to a protectionist world. If the new Trump administration carries out its threats of forcing companies to bring back manufacturing to the US while imposing tariffs, Asia will suffer the brunt of that policy shift. This in turn could lead to currency devaluations and a spiral down in the free flow of goods and capital. This scenario is possible, but with so little known about the President-elect’s personnel and policy, we are still in the realms of guessing.

As markets calibrate to possible worst-case outcomes, this will throw up opportunities to buy businesses that will not be that badly affected or at valuations that are reasonable given the risks. There is no doubt that conditions are starting to change. Mehta will have to cut back on some Indian and Taiwanese holdings while we reassess the impact of market moves on underlying businesses. As he mentioned at the start, he has no coherent answers since these moves in markets are macro-oriented, volatile and rapid. In the past, patience has paid us good dividends. Mehta believes it will be no different this time around as well.